1. Centrica plc (Centrica) is the parent company
of British Gas, the UK's largest energy supplier with around 16
million customer contacts in the domestic sector and around one
million in the non-domestic sector.

2. We also own upstream gas production and power
generation assets to support our supply businesses. Specifically:

 we
own eight gas-fired power stations including Langage, one of Britain's
newest and most efficient gas power stations;

 we
are the largest UK supplier of offshore wind and recently won
the rights to develop over 4GW of Round 3 offshore wind in
the Irish sea;

 through
our Joint Venture with EDF Energy we own 20% of British Energy,
the nuclear generator, and we also have the option to participate
in the nuclear new build programme with EDF; and

 finally
as one of the largest installers of microgeneration including
Solar PV and Heat Pumps, we also have a major interest in small
scale electricity generation.

3. We welcome the opportunity to respond to the
DECC Select Committee Inquiry into Electricity Market Reform (EMR).
Subsequent to the announcement of the Inquiry, DECC has published
its EMR consultation providing further clarity on the proposals
being considered. We are still assessing these proposals and -
for the purposes of this evidence - are not yet in a position
to come to a final view on some of the specifics, so instead have
highlighted some general principles. Noting the wide scope of
the Inquiry questions we have grouped our evidence around a number
of key themes as highlighted in the DECC consultation.

EMR FOCUS

4. We believe that the EMR is broadly focused
on the right priorities.

5. The current market-based arrangements have
served the UK exceptionally well and the UK has enjoyed considerable
security of supply. This has been achieved through a competitive
wholesale market that maximises the operational efficiency of
the existing fleet and has supported new construction, such as
Centrica's newly operational Langage power station. The customer
has also benefited, with UK electricity prices being on average
amongst the lowest in the EU 15 over the past five years.

6. The Renewables Obligation, designed to meet
the UK's renewables targets, has also resulted in the construction
of over 5GW of wind generation. The UK is now the leader in offshore
wind.

7. However, the current arrangements do not provide
the market signals to ensure that there is sufficient diverse
low carbon generation investment to meet the UK's carbon
targets.

8. In addition, as the proportion of intermittent
renewables generation from wind power increases, the electricity
system will come under increasing strain at times of low wind
output and high demand. We do not believe that current arrangements
provide the investment signal needed to ensure flexible plant
would be available to back up this intermittent generation in
order to guarantee security of supply.

9. It is therefore appropriate that the EMR focus
on:

(a) options to encourage greater investment in
all low carbon generation; being a combination of a carbon price
floor and low-carbon generation revenue support; and

(b) targeted capacity payments to ensure security
of supply by rewarding flexibility in the context of greater intermittent
generation

10. We strongly welcome DECC's focus on the importance
of a smooth transition in order to minimize the associated investment
hiatus. This is particularly important if renewable generation
investments are to continue in order to meet the UK's renewables
targets, and guaranteed grandfathering of existing rights is an
important principle.

11. If implemented effectively, we believe that
the key components of DECC's EMR package will deliver a durable
new market framework enabling investments needed to meet the UK's
energy policy goals. Specifically, the essential ingredients are
the combination of: a meaningful carbon price floor, appropriate
additional revenue support for low carbon generation, and capacity
payments for flexible generation. We believe that where possible,
the benefits of a liberalised market must be maintained in order
to contain costs for consumers and ensure that private sector
is bearing appropriate risks. Both DECC and Ofgem recognise the
importance of wholesale power market liquidity and it will be
important to consider any potentially adverse impacts from the
implementation of EMR.

CARBON PRICE

12. We strongly welcome the proposal for a carbon
price floor as part of the EMR package. This ensures a clear economic
signal to the market consistent with the "polluter pays"
principle; the higher the floor, the stronger the signal. The
proposed introduction by 2013 is welcome and in doing so the floor
can make a meaningful contribution to lowering the UK's short
term carbon emissions and encouraging new low carbon investment.
The carbon price floor encourages lower carbon dispatch, thereby
lowering the UK's carbon emissions. It also provides a long-term
and durable economic signal by which to make investment decisions.
While all taxes are subject to change, we believe investors would
not discount the value of a carbon price floor because of this.
We believe investors will see it as enhancing the economics of
low carbon generation and will rely on it being in place for the
long term.

13. DECC's EMR consultation outlines two main
options, a Premium Feed-in Tariff (PFIT) and a Contract for Difference
Feed-in Tariff (CfD), with a preference for the latter. In essence,
the PFIT is a top-up payment in addition to the wholesale electricity
price, whereas the CfD provides fixed revenue support.

14. A Premium FIT is closest to the existing
market structure and maintains the strongest market forces for
all generators. It would only require modest reforms for the RO
to become a PFIT and could continue to be banded so that different
technologies receive different support levels. It therefore minimizes
investment hiatus, given its relative simplicity and modest reforms
to the RO, which is well understood by investors.

15. A Contract for Difference FIT represents
a more fundamental change in the market, by removing long-term
wholesale price risk from the generator. As such, there are more
fundamental questions and long-term consequences we have yet to
fully consider. These issues are not necessarily insurmountable,
but do need to be thought through before embarking on the CfD.

16. Issues include the need to better understand
the impact on market liquidity. If generators have long-term CfDs
against an index (eg against annual average prices), they are
likely to want to sell power into the wholesale market as close
to that index as possible lower their risks. This could reduce
market liquidity which could be a barrier to new entry and could
restrict suppliers' ability to hedge. More broadly, as increasing
proportions of the generation market become largely fixed price,
we would need to understand the implications for the electricity
retail market: suppliers' ability to compete on price and product
innovation could be impeded. There are also important implementation
questions to be answered such as who will the counter-party to
the contract be eg Government/ Ofgem? And how will they raise
revenue eg customers, taxpayer? And finally what are the implications
for UK customers if increasing parts of generation are locked
in to a CfD price set by Government, but commodity prices shift
unexpectedly downwards (eg as a result of an expansion of shale
gas)? Some of the UK's competitors would not be locked into similar
contracts and precedent has shown Government's poor ability to
predict future prices with any degree of certainty.

17. For both a CfD and a PFIT setting accurate
levels of support is challenging. DECC has expressed a preference
for auctioning. While this is the more theoretically appealing
approach, practical experience demonstrates that Government auctioning
processes can cause significant delays and be flawed in their
design and implementation.[58]
A more practical approach may be one that builds on the precedent
of the banding process for the RO, in which Government sets the
price level with periodic reviews expected. The level is set on
the basis of a range of factors eg commodity price trends, information
disclosure from participants and the supply chain, and the volume
of investment Government wants to encourage. We believe that this
is more appropriate given the early stage of some technologies
in either their deployment in the UK or in their technical evolution.

EMISSIONS PERFORMANCE
STANDARDS

18. If a carbon floor and low carbon generation
support mechanism are implemented correctly, the need for an EPS
is redundant. The risk of introducing an EPS is that flexible
gas-fired generation that is required to back up wind generation
will not get build. DECC's proposals is that any EPS will be limited
in its application, to new coal, which we support. However, we
note that some groups have already been calling for this to be
extended to gas, which impacts on investor confidence.

CAPACITY/FLEXIBILITY
MECHANISMS

19. Given the potentially important role gas
will play as a lower carbon transition fuel, it is important that
market incentives to encourage low carbon do not crowd this technology
out. Unprecedented amounts of generation plant are likely to close
in the next few years to due to age or environmental regulations.
It is highly unlikely that new nuclear and renewables will fill
this gap in the short to medium term - and too great a risk to
rely on them doing so - but new gas power stations may be crowded
out in the post-EMR landscape because of the expectation of declining
load factors and poor returns on investment. This would impact
on security of supply.

20. In addition, as greater intermittent renewables
come online, flexible plant will be required to back-up these
renewables, which is unlikely to be nuclear or CCS which tend
to be less flexible baseload technologies. Therefore, the economic
incentives need to be in place to ensure efficient, flexible,
and relatively low carbon options are available to play a back-up
role, where these plants are operating at a much reduced load
factor and potentially faced with depressed prices for large periods.
This is not just a question of investment in new gas-fired plants,
since there are also important refurbishment/life-extension decisions
to be made in respect of existing stations in the coming years.
Suitable backup plants could close without new plants being built
to replace them, if the signals are not there to stay online,
jeopardising security of supply.

21. We support DECC's decision to introduce targeted
incentives to ensure that the appropriate plant should be retained
or built to ensure security of supply. We believe that the emphasis
should be on flexible, relatively low carbon plant, either existing
or new. A blanket capacity payment to all technologies would represent
a fundamental intervention in the market which could lead to distortions
and unintended consequences. Since it would reward all generation,
irrespective of the characteristics desired, there may be greater
value in keeping old inflexible plant on the system rather than
rewarding flexible and, likely, lower carbon intensive options.
We therefore support a targeted mechanism rewarding the characteristics
required, specifically flexibility.

22. If designed correctly, an economically efficient
capacity mechanism would encourage moderately efficient CCGTs
to stay on the system beyond what would otherwise be their economic
closure date /or encourage new, efficient CCGTs or OCGTs to be
built. In time we believe other technologies could play a role,
but they are not yet economically efficient, and the carbon benefits
of disproportionately supporting them would be relatively low
given their low load factor. As smart meters become more widespread
in the residential and business sectors, the demand side could
also contribute to providing flexible capacity (so called "negawatts"),
as may storage. It is therefore important to design the capacity
mechanism so it is neutral to the qualifying technology and focuses
on the characteristics required. Ultimately, it is crucial that
the mechanism is targeted and focused on rewarding the most cost-effective
options, to minimise distortions in the market and therefore lower
any costs to consumers.

CONCLUSION

24. On their own, the EMR policy components represent
significant changes to the market. As a package, they represent
a fundamental renewal. This is appropriate, given the scale of
the challenge ahead. However, given the strong benefits the UK
gains from the current market structures, where possible it is
important to retain features intrinsic to liberalised markets,
so customers can benefit.